The Reserve Bank of Australia cut its benchmark interest rate by a quarter percentage point to the lowest since 2009 as Europe’s debt crisis and slower Chinese growth overshadowed a stronger domestic labor market.

Governor Glenn Stevens and his board lowered the overnight cash rate target to 3.5 percent, the RBA said in a statement in Sydney today. . . .

The jobless rate in Australia [4.9%] is less than half the 11 percent in the euro area and lower than the U.S.’s 8.2 percent. In his statement, Stevens noted the local job market’s improvement. . . .

The RBA, in its quarterly monetary policy statement released May 4, cut growth and inflation forecasts. It predicted average growth of 3 percent in 2012, down from a February estimate of 3.5 percent. Consumer prices will rise 2.5 percent in the year to December, from a previous prediction of 3 percent; underlying inflation is forecast at 2.25 percent from a previous estimate of 2.75 percent, the RBA said.

Today, Stevens said: “The board judged that, with modest domestic growth and a weaker and more uncertain international environment, the outlook for inflation afforded scope for a more accommodative stance of monetary policy.”

Forget about the implied 5.5% NGDP growth forecast. Australia has a 2-3% inflation target and faster trend RGDP growth than the US. That sort of nominal growth would be beyond my wildest dreams for the US. Rather think about how proactive they are. Unemployment is low and inflation is in the sweet spot. But they are easing monetary policy because they see the global slowdown, which for some reason the much more sophisticated Fed and ECB don’t quite comprehend. They aren’t cutting rates because 5.5% NGDP growth is too low, they are cutting rates to make sure that 5.5% NGDP growth happens.

The Fed seems content to wait until our recovery is off the rails, and then pull out still another QE, each one less stimulative than the last, because they mostly work via signalling. Every time the Fed fails to carry through it losses a little more credibility. And the biggest irony is that the credibility loss they are worried about is too much inflation! That’d be like Mitt Romney worrying that people will regard him as too spontaneous and reckless.

I’m a little confused. The RBA was predicting a 6.5% NGDP rise. Now it’s predicting a 5.5% NGDP rise. Doesn’t that mean it’s not targeting the forecast? Because if it were targeting the forecast, then its prediction of nominal growth would remain unchanged, and it would say, “We are forecasting a real growth of 3%, down from our previous forecast of 3.5%, and we are forecasting consumer prices rising 2.5%, up from our previous forecast of 2%.”

Neal, My bad, they are failing to target the forecast. My point was slightly different. The new inflation forecast is within the Australia target. And even 3% RGDP growth is quite good. And yet they cut rates, to make sure it doesn’t fall below the target range. The Fed would stand pat. But you are quite right that I implied they are precisely targeting the forecast, and that’s overstating things.

“The Fed seems content to wait until our recovery is off the rails, and then pull out still another QE, each one less stimulative than the last, because they mostly work via signalling.”

That’s why I sadly keep agreeing more and more with this Brad Delong post:

What Can Ben Bernanke Do Now to Summon the Confidence Fairy?

At this stage, I don’t think there is ANYTHING he can do. Since the fall of 2009 he has misread the situation: been dovish, then hawkish, seen “green shoots”, contemplative, then decisive, then a victory lap, then hawkish, then dovish, dovish again, oh—then hawkish.

Declarations that the Federal Reserve is about to undertake QE III or Twist II simply won’t alter market expectations about the future path of the price level or nominal income anymore (if they ever would have) and so won’t induce any increase in the flow of spending.

It’s more of a zero lower bound issue (although the RBA deserves credit for avoiding the ZLB). I’m sure you’ve made this point before, but the hawks need to realize that by raising the cost of hitting the ZLB they are increasing the chance of excessive NGDP growth (and “uncertainly”) in the future.

And this was after the RBA cut by 50 bp in May. The question is, does it matter that the latest RBA cut was slightly below market expectations and does it matter that the market is expecting a further 120 bp of cuts over the next few months, which the RBA is unlikely to deliver?

Very interesting, Australian q/q GDP was 1.3% (not annualised) and 4.3% y/y. But the GDP deflator was -0.3%, leaving NGDP at 4.1%. And everyone except for miners is miserable. More evidence, Scott, that what matters to people is NGDP, not ‘real’ growth.

Liberal Roman, There may be nothing Bernanke can do (I can’t say) but there are certainly things the Fed could do.

You may be right about the RBA

Adam, I looked at it. He seems to take a very mechanical approach, ignoring expectations. And he ignores the fact that QE2 did affect the markets. The task we have as economists is to explain why it affected the markets, not develop models that say it never should have affected markets, but did.

Let me know if Kimball ever replies to my comments.

Rajat, Whatever the market expects is what the RBA is likely to do. (And yes, it’s market expectations that matter in the short run.)

Antipode. The 3% target has two advantages; Less likely to hit zero bound, and less downward real wage inflexibility.

The advantage of a 2% rate is a lower tax on capital. But it’s easier to do the 3% and combine it with tax reform.)

[…] In particular, major increases in the (domestic) demand for money unmatched by changes in money supply have not occurred so as to lead to crashes in transactions. Having a central bank responsive to both inflationary pressures and shifts in output has successfully anchored expectations, as the RBA has balanced credibility. Since the RBA is accountable for both the value of money and the level of transactions, we have also had beneficial reputation effects operating on our central bank officials. (Which shows up in its statements and actions.) […]

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Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.